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Inside Look: A Wealth Planning Case Study (Part 3 of 3)

Published on February 26, 2024

John Hagensen

Over the past three weeks, we’ve followed the Smiths’ financial journey, exploring goals like retirement, funding their grandchildren’s educations and leaving a lasting legacy. In this episode, you’ll find out what changes are needed in the Smiths’ plan to achieve these objectives. (31:13) You’ll also learn the importance of a comprehensive wealth plan. Plus, join John and Creative Planning’s Director of Tax Services for insights on maximizing tax advantages with IRAs, HSAs and 529 plans. (10:05)

Episode Notes:

Presented by Creative Planning, each week Host and Managing Director John Hagensen cuts through the headlines and loud takes to challenge the advice you may have been given and reaffirm what you know to be true. Plus, don’t miss his weekly interviews with Creative Planning specialists as they cover investing, taxes, estate planning and many other areas that impact your financial life!

John Hagensen: Welcome to the Rethink Your Money Podcast, presented by Creative Planning. I’m John Hagensen and ahead on today’s show, the financial planning answers for success, whether we like to hear them or not, the recommendations visit of our client case study, as well as the most effective way to reduce the risk of market declines. Now, join me as I help you rethink your money.

Over the President’s Day weekend holiday, we took the kids to the beach in San Diego, had a fantastic time, but one of the things that can happen on vacation is you get off your routine. The kids end up consuming a lot more sugar than normal. They go to bed later. And then as a parent, I’m wondering why things are going off the rails. Kid’s behavior is bad. They’re jumping on furniture. And the answer is probably not what I want to hear, but the fact that I gave them one of those ice cream sundaes with churros submerged all throughout the top.

But this happens a lot in life, the correct answers are the ones that we don’t want to hear. I was thinking about this with sports. Can you imagine the end of the Super Bowl or an NBA championship, maybe the World Series where the entire stadium’s fans rush onto the court or field around all the players, both the winning players, the losing players, and it’s just a stampede.

Well, of course that would be unsafe, but in college sports, this still happens regularly. I get it, it’s fun, but the correct answer is the one we don’t want to hear. Why are we still in 2024 rushing to court? Well, I love this one. My wife was telling me the other day that on her Instagram account there was an advertisement for a pill to get rid of hangovers. Like this is the epitome of the correct answer is the one we don’t want to hear. If you’re someone who drinks way too much and you wake up with a throbbing headache, this’ll help. Not the answer of drink a little less, maybe not at all. You’ll probably feel better. That’s not an answer we want to hear. Give me a weight loss drug. I don’t want to go to the gym. We do this all the time in life and we certainly do it with investing.

As a certified financial planner, I’ve seen this throughout my years and frankly I personally do this. I’m not immune to it in my own life just because I’m a wealth manager, but let me share with you five pieces of money advice that none of us want to hear but are very important to your success. Number one, you’re not saving enough. If you save 20% of your pay from the very beginning, you’ll have so much extra money, you’ll be swimming around in a money bank like Scrooge McDuck, and even if you save 10%, you’ll probably still be in a great position. Consider this $1,500 a month from age 27 to 67, which would be 18 grand a year, so about 20% if you averaged $100,000 per year as a household. You don’t even earn the historical average of 10%. Let’s just say you make 7% per year for those 40 working years. You have a balance of $4 million at retirement, 720,000 of it being contributions, and 3.2 million attributed to growth, which is pretty powerful, isn’t it? 18% of your balance is all that’s made up of your contributions.

But let’s say you even save more. From 27 to 67, you’re married and you both max out your 401(k)s. You probably get a match as well, 48 grand a year, 24K each. At 7%, you’d have $10.5 million as a household at age 67. And while I know the purchasing power of $10.5 million would be less 40 years later due to inflation, it’s still a lot of money. And so here’s the reality. There are two ways to save more money, figure out a way to earn more money or figure out a way to spend less. Maybe it’s a combination of both.

Second piece of financial advice that clients never want to hear, you can’t retire that early. Compound interest is wild. That exponential growth is hard for us to conceptualize. But using the same example above, if you retired at age 57 instead of 67, the $10.5 million balance drops all the way to 4.8 million. You’re not receiving the benefit of that final decade of compound interest.

Think of why this is so impactful. You don’t save for the final 10 years, and you don’t receive the compound interest on all of that money during the final 10 years because you’re taking withdrawals 10 years earlier. And you’ll need those withdrawals on a much longer remaining life expectancy because you’re only 57 years old. So moving retirement just a few years back can significantly boost your likelihood of not running out of money, but something we don’t often like to hear. How about this one? You need to take on more risk. Very few people earn enough and save enough to just buy treasuries and CDs and sit in money markets and make their financial plan work and accomplish all of their goals. Same example above. Instead of 10 and a half million dollars, you’d retire with about 3.7 at historical risk-free rates of return. And here’s the key, the volatility isn’t a negative, it’s the toll for driving on the road. It’s your access to superior returns. You can’t have one without the other.

One of my children, our four-year-old Aria is sassy. She has a big personality, but she’s also incredibly bright. She can make a conversation with anyone. This last weekend in San Diego, she was standing there looking at a rollercoaster ride that her older siblings were on. A sweet lady looked at her and said, “Oh, are you going to go on the ride?” And quick-witted Aria said, “Oh no. I’m way too short and too young to go on that ride, but maybe when I’m 17 years old, I’ll go on it.” And the lady just burst out laughing and she kind of looked at me and said, “Oh dad, she’s a funny one.” And she is, and she’s an incredibly quick thinker and communicator and she has crazy emotional intelligence for her age. She can carry on full conversations with strangers at four years old, but I can’t expect to have that and then expect her to not have other independent thoughts or strong opinions about how I cut her PB&J sandwich. That’s what makes her her, and that’s what makes the stock market returns what they are. You don’t get a historical average return of 10% per year for a century more than double what you receive in safe investments without volatility. Take away the volatility, take away the returns. And remember in my example from 27 until 67, you actually are rooting for down markets so that you can be buying low. The only time you want the markets high is when you’re selling investments.

Fourth piece of money advice clients never want to hear, you can’t afford that much house. Most people ask their lender what they can qualify for. Then they go to their realtor and relay that information, “Here’s our budget.” But going up to the limits on your home can massively impact your flexibility, your savings rate, probably most importantly, your stress level, being house poor and then having to pinch pennies everywhere else as a result of your own doing is no fun.

Here’s what I personally found is most important with a home, functionality for your family. Does the layout work? Do you have enough bedrooms? For us, having a yard, in Arizona, having a pool, hundreds of hours of entertainment for our children every year, especially when it’s 110 degrees outside. Location is always one of the most important factors with a real estate purchase. And then for us, walkability or golf cart ability. Our kids’ school is in the neighborhood, got a coffee shop in the neighborhood, other restaurants, all of that, a lot more important than the, quote unquote, “niceness of the house, the finishes of the home.”

Now, all of this is specific to you. Probably prioritize things differently than I do, but whatever it is, make sure you’re not overextending, trying to impress people who don’t care that you probably don’t even like.

And the fifth and final piece of money advice that can be difficult to hear, be patient. There is no get rich quick strategy that doesn’t also involve the prospect of you going poor quickly. And of course, sometimes we have the answers to the test, but the challenge isn’t in the knowing, it’s in the doing. The most important answer, the first step is to have a written, documented, dynamic financial plan. And if you aren’t sure where to turn, we are happy to help here at Creative Planning. We are fiduciaries assisting 75,000 clients. We have 465 certified financial planners, over 200 CPAs, over 50 attorneys. We’ve engineered and managed tens of thousands of financial plans. If you’d like to speak with a wealth manager just like myself, visit creativeplanning.com/radio.

It’s time for this week’s one simple task. Today’s tip, begin gathering your tax documents in preparation for April 15th, things like last year’s taxes, W-2s that you’ve received, 1099s. If you’re a homeowner, Form 1098-E, education expenses, 1098-T, contribution information, documentation on retirement plan contributions that are tax-deductible. If you contributed to a 529 plan and your state offers a tax benefit, you’ll want to keep that information on hand as well, realize gain and loss reports, any K-1s for partnerships, S-corps, trusts which are common with non-traded investments, any supporting documentation for tax deductions or credits, social security numbers for family members, charitable donations, estimated tax payments that you already sent to the government as well as your bank account information.

Now I know you’re thinking to yourself right now, “John, that is not one simple task.” Well, how about you do this for now? Start a file somewhere, whether it is a paper file or one on your computer’s desktop, and as you receive these forms, consolidate them all into one place. Don’t bring a shoebox with 130 unopened envelopes and dump it on your CPA’s desk on April 14th. That is just cruel. So again, your one simple task, gather tax documents in preparation for the filing deadline.

Well, it’s the most wonderful time of the year and nope, I’m not talking about much mistletoeing, anything related to Christmas, although if my wife Brittany, if you’re listening, I’m good with that too. But no, of course I’m talking about the other most wonderful time of the year and that is tax season, 1099s arriving, W-2s. I know you’re waiting by your mailbox. You can’t wait to receive them. And to discuss this topic more, I have a special guest who I was able to pull away from his day job for a few minutes. Ben Hake is the director of tax services here at Creative Planning, overseeing tens of thousands of tax returns each year. Ben Hake, thank you for joining me on Rethink Your Money.

Ben Hake: Thank you for having me, John. How’s life?

John: Life’s good. How about you?

Ben: Fantastic. It is great in Kansas City right now.

John: Taxes are top of mind this time of year, but would you agree, Ben, the planning piece during the year for subsequent years is where more energy should be directed?

Ben: 100%. From our perspective, the return is the end product, but that’s not really what we’re spending our time on and where the real value is. You’re very much correct that touching base throughout the year are there actions we can take, are there things we should be considering that once the calendar ticks over past December 31st, the opportunity’s gone and now we are just reporting history at that point in time.

John: And there are some things that you can do after 12-31. And we’ll look at tax advantaged, retirement accounts, as well as health savings and some of these others. Can you start by running through some of those and provide the deadline for when people can contribute to those?

Ben: I think it’s important to point out there’s two ways that that can happen. The first is going to be we get a deduction for putting something in, which is pretty common for those retirement accounts where, “Hey, I’ve put in $7,000, I get to reduce my income by $7,000 for that.” Or the other advantage you can get is that the income and growth that occurs within that account is no longer taxable, so you don’t pay along the way taxes.

Ben: And so the very common one that everyone is familiar with is retirement plans. So most of these are provided by their employer, so you’ve got a simple IRA or a 401(k) plan. Those allow you to defer a part of your pay and be able to reduce your taxable income for there. The other one is let’s say you don’t have an employer sponsored plan, then the IRS would provide you an IRA. So that’s one where you can put up to $7,500 or $6,500 depending upon your age, and then you’ve got until the filing deadline of your return to actually fund into that. So that’s one of the ones that we keep in our back pocket where if we’ve got somebody who’s on a threshold of something, maybe Affordable Care Act credits or child or dependent care credits, we could use the IRA to reduce their income for that and that’s after the year-end planning.

John: I think it’s important too to remind listeners that it reduces your income in the current year by deferring income. But I think so often, that word deferral is used synonymously with eliminating or saving this much money on my taxes. So I put 10 grand in my 401(k), I’m in a 24% bracket. I just saved $2,400 on my taxes, and really the only savings is going to be when you pull the money out and you have to finally recognize that $10,000, are you in a lower tax bracket than 24%? And certainly if you’re in a 10% bracket, yeah, you saved $1,400 on your taxes in the end, but it’s not a full savings because you are simply pushing that income until later.

So I think sometimes we, I don’t want to say overestimate, but a little bit. Maybe that is the right word that we overestimate how much benefit we’re gaining, certainly if we’re not in a high bracket, which leads us into Roth’s, which I think is where you were going to go next. Let’s talk about Roth’s as sort of the counter to pushing that income into the future.

Ben: Correct. And just like you said, we’re always looking at what’s the immediate savings now for a traditional IRA or most pre-tax retirement accounts, what’s the tax rate when we pull it out? That spread is the lifetime savings you can get on that. Now maybe you’ve got the opposite scenario where it’s like, “Hey, we’ve got relatively low income.” Well, that’s when a Roth IRA may be more advantageous to you. So we don’t get any pre-tax deduction using post-tax dollars to put in, but that growth occurs tax-free and on the backend when we take it out, it is also tax-free. So there’s no secondary taxable event when we withdraw the funds from that. So that’s a scenario and it doesn’t always with rates low right now because of the tax cuts and Jobs Act, we’ve had some people on the 22 and 24% bracket who are still taking advantage of Roth accounts because the expectation is that at some point in the future, the tax rate they’re going to pay will be going up.

John: Well, yeah, I mean married filing jointly at 360 grand, you’re still in a 24% bracket, and so there can be in some cases, pretty high income earners that still choose. Now they make too much money to contribute to a Roth IRA, but maybe they can do a backdoor Roth or maybe they can max out the Roth 401(k) because those aren’t income restricted. So those are some of those opportunities that I think it’s worth having a conversation with someone like you and your team, looking at it with your certified financial planner and saying, “Yeah, I’m a physician. I’ve always maxed out my SEP IRA. But wow, even though I’m making 360 grand, I’m only in a 24% bracket. Should I be doing that for these next couple of years prior to the Trump Tax Reform sunsetting?” Ben, when are the deadlines to contribute to a traditional IRA, a SEP IRA, a Roth IRA, and then their company retirement plans?

Ben: So we’ll start with what do you need to do the soonest versus what do you have the longest amount of time for?

John: Perfect.

Ben: So for your employer provided plans, so your 401(k), simple IRA, those need to be done during the calendar year.

John: Correct.

Ben: So as you get close to a year, and if you’re like, “Hey, I’m short five grand from the max,” and I really want to hit it this year, you would need to adjust your paychecks for those remaining ones in the year.

John: Which is why we tell people to look at that now for 2024, start looking at it early in the year to make sure that you don’t get in a scenario where, to max it out, you can’t take a paycheck for the final month and a half of the year because you don’t get into the new year to take advantage of that. So that’s really important for people to understand.

Ben: Correct. So then the next one would be traditional IRA and Roth IRA and those you’ve got until the filing deadline of the return. So generally speaking, April 15th moves back a day or two depending upon where it falls, but that would be the next one. But then the final one would be the SEP IRA or your self-employed retirement plans. Many of those when you extend your tax return in April, it also extends out the deadline to fund that retirement plan contribution. So those generally are either going to be September 15th or October 15th depending upon the type of return or business that has that plan.

John: I am almost certain that you’ve experienced this multiple times. I certainly have as a wealth manager where the client in September says, “All right, I am going to max out my SEP IRA.” Well, it doesn’t completely eliminate their tax. It reduces it because of the deduction, but it doesn’t eliminate it.

John: So now they’ve got to have enough money, and this is where the planning comes in, to be able to max out that SEP IRA and still have money left over at the end of that to also pay their taxes, which is why you do want to plan ahead for this because I’ve had people that want to fund their SEP, but they say, “Once I make that 60 grand to my SEP, I don’t have another 80 to pay the taxes. I mean, it’s great that my taxes just went down from 110 to 80, but I still need to come up with 140,000 instead of 110. I’ve got 110, I don’t have 140.” So that’s where it can be really important again to work on these things well in advance so that you don’t get caught in a scenario where you want to contribute and simply aren’t able to. Let’s shift over, Ben, to health savings accounts. What are the deadlines on those and some of the tax advantages of those accounts?

Ben: It has the benefits of all the other ones. So basically like an IRA or a traditional IRA, when you fund the HSA, you get a deduction for that upfront, when the funds are within the account, if you’re invested in a brokerage account through your HSA, there’s no tax due on that growth. But like the Roth IRA, when you take the funds out, if they’re used for medical costs, there’s no secondary tax consequence there. So for the HSA, if you do it correctly, you get the deduction, the deferral and the long-term exclusion of that income from being taxed. So it could be really valuable for a lot of our clients.

John: Certainly if you have the means to fund it, it’s the absolute no-brainer with that triple tax treatment. I not only max it out personally, but then I don’t spend any of the money from it. With seven kids, we’ve got a ton of medical expenses, and I could drain it down every single year, which would still be better than not contributing. We’d be spending pre-tax dollars to pay for medical costs, which is fantastic, but I like the benefit of the tax deferred growth and taking it out tax-exempt if used for qualified medical expenses. So I just pay out of pocket for my medical expenses, have the HSA invested because that’s to me where you really get that third leg of the stool, the value of it. Again, you have to have enough cashflow to be able to do that, but you’re really able to optimize that type of account. Typically, medical expenses increase the older you get, and so now you’ve got a bigger bucket of money. And if you don’t spend it, I get this question a lot, “Well, Ben, what if I don’t spend the HSA and I die with $300,000 in an HSA?” Is it a use it or lose it? Is it gone? Can you explain what happens to an HSA if you pass away?

Ben: Yeah, generally speaking, the HSA is going to have a successor beneficiary noted on there. Those funds would roll to them. Now that may be a taxable event to them based on your basis-

John: But if it’s a spouse, it goes over just as is?

Ben: Correct, yes. I’m envisioning a scenario where it’s not going over to a spouse, that’s a tax-free event. But if it were to go to the beneficiary, let’s say a child or some other beneficiary of that, it’s a taxable event, but again, you got likely decades of growth that was occurring tax-free on that, so still very much not the end of the world or the worst outcome.

John: Yeah. You pretty much just treat it as a 401(k) that’s being inherited or an IRA, right? You got the tax deduction in, tax deferred growth, it comes out taxable to a beneficiary just as if they were inheriting your 401(k) that you saved. So still not a horrible scenario. I’m speaking with creative planning director of tax services, certified public accountant, Ben Hake. Let’s transition over to some less thought of tax advantaged accounts. Let’s start with 529 accounts, Ben.

Ben: After the IRAs and HSAs, this is probably the next most well-known. So this is a program that the IRS created to allow taxpayers to save for higher education costs, and that’s any sort of higher education, so not just tuition, it could be room and board, meal plans. It’s a little different, so when you put the money in, there’s no immediate tax benefit federally. Now many states have programs where they’ll say, “Hey, the first five grand is a state level income tax deduction or kind of tears up,” but federally there’s no benefit, but it does allow you to deposit funds in there and then you get tax-free growth up until its distribution.

Ben: Over time, the IRS has expanded it. When it was originally created, it was just higher ed. 2017, they opened it up and said, “Hey, if you’ve got private K-12 tuition, you could do up to 10 grand a year and use it for that.” And starting this year in 2024, it’s probably the most interesting expansion I’ve seen so far, which is that if you meet a couple of specific criterias, if the 529 funds are unused by the time the kid’s done with school, which isn’t an uncommon situation, if it’s been the kid’s account for 15 years and the money’s been in there for at least five, the IRS will actually allow you to roll that over to a Roth IRA for the child up to $35,000 new, very unique item, but our clients are pretty interested in it.

John: The biggest negative and deterrent to funding 529s is that people would say, “Well, what if I stuff a bunch of money in there? I don’t get a federal benefit on the way in.” Yeah, state’s helpful, especially for higher income earners in somewhere like California, but they look at it and say, “Well, what if my kid’s entrepreneurial? What if my kid goes to the military and then gets out and gets a GI bill? What if they’re super smart and they get a full ride to an Ivy League school and I’ve got all this money sitting in a 529?” So I think there was an apprehensiveness to really fund those aggressively due to the rigidity and lack of flexibility. Let’s go over to the Coverdell education savings account. Certainly way less common and less well known than the 529, but still has some opportunities. Can you break those down from a tax standpoint?

Ben: Yeah, so the 529 I would say is almost an unlimited annual contribution. Now, there may be state level plan requirements that say, “Hey, you can’t put a million dollars into this,” but generally speaking, if you wanted to put 15, $17,000 each year, totally allowed with the 529 plans.

John: Yeah. There’s certain states, Ben, where I think you can put 400,000 or 500,000 over the lifetime of it. I mean, it’s really high limits. I think that surprises people.

Ben: Well, and with tuition costs, four or $500,000 might be needed for-

John: Yeah, yeah, yeah, exactly.

Ben: … prestigious universities.

John: Yeah, absolutely.

Ben: But with the Coverdell account, so unlike that where you can put really large amounts, in the Coverdell is capped at a $2,000 per beneficiary annually. The other part that makes it a little trickier is it has an income limit. So if you’re a married couple, once you make about $220,000, the IRS says you’ve made too much and no longer contribute to the Coverdell plan. So it’s much more common I think in our clients would be using the 529 one. The big reason that a lot of people use the Coverdell is it’s no longer a state-sponsored plan. So there they may have a couple of investment options, maybe a relatively small grouping of them versus with the Coverdell it’s basically anything you can invest in a brokerage account. So some people like that flexibility on that side, even though it’s a much smaller amount that you’re able to put in.

John: Yeah, they want to day trade penny stocks for their child’s education. They’re like, “I can’t do that in a 529, so I’m going to open this Coverdell.” That’s pretty interesting. How about able accounts?

Ben: This is probably one of the lesser known ones, but just like 529s, these were created, but to basically be able to support a different cause, which is going to be an individual with disabilities. Right now, that disability has to occur before the age of 26, but here in 2026, the IRS is expanding that so that if you’re disabled from age 46 or younger, you’d be able to participate in this.

John: Which is a big change. I mean, 20 years difference. That’s really important.

Ben: Exactly. So it’s something that would happen more like maybe less at birth versus something that occurred later on in life. The big thing is that these have an account you could put $18,000 in per year, but that’s per beneficiary and there’s no restriction as to who that could come from. So that can come from friends, family, maybe the individual already has a special needs trust, they could fund into that. And it can even come from a 529 account. So maybe they start with a 529, something transpires and that’s no longer an option, the ABLE account is something that could be able to accept that.  The other thing that’s a little unique about these is so you could do 18 grand just as an annual contribution. And if the individual of the beneficiary is working, then the IRS also will say, “Hey, if you don’t have an employer-sponsored plan, you can save some of your earnings and put it into this ABLE account.” And so you’ve got this pot of money in the ABLE account and now you’re able to use that for really any qualified disability expense, which could be food, housing, transportation, education, training and support. There’s a wide spectrum of those, and the other thing that a lot of people like is it’s not nearly as restrictive as the special needs trust environment. This doesn’t have a separate trustee or things like that, so it gives you a little more flexibility on what to spend the funds on.

John: Well, that’s a really good breakdown of the ABLE account. Obviously no one wants to pay more taxes than legally required, and these are all different tools within the toolbox to be able to utilize depending upon your situation. I think you’ve broken these down in a really understandable way. Thank you as always for joining me here on Rethink Your Money, Ben.

Ben: Thanks, John.

John: I’m often asked some variation of the question, how do I minimize the risk of losing money in the stock market? One of the simplest and most effective ways to minimize the risk and uncertainty of volatility in the stock market is to do what’s called dollar cost averaging. Dollar cost averaging involves buying a fixed amount of securities at regular intervals regardless of the price. Now, did you catch what I said in there, where that might apply to your life? It’s your 401(k) plan. It’s your TSP, it’s your 403(b), where every two weeks, money is pulled from your paycheck and invested into the stock market. When you contribute over 10, 20, 30, 40 years every two weeks, the result is that you’ll pay the average price of the market during that time. Think about this another way. For 30 years, once per year you bought a rental property, you’d look back after three decades and think to yourself, “I paid a lot in ’05, ’06. Conversely, I bought some that were dirt cheap in 2009 and 2010 and over time, prices increased, so everything I bought a long time ago looks really attractive in hindsight,” but you’d pay the average price of the real estate market over the last three decades. Well, this minimizes the risk of volatility because in prolonged periods where the market is down in value, you’re buying at really attractive prices. And when it comes to your 401(k), that’s the only way to invest. But where I see this confound people is when they inherit money, when they sell a business, when they have some sort of liquidity event, and now they’re sitting on a lump sum. And if it’s as it is today, markets are near all time highs. And the question often is, “Should I take this million dollars that I just received, put it in a money market, and then over the next 12 quarters invest 1/12th of the balance so I can get the average price over the next three years just in case right now isn’t the ‘right time,'” and I’m putting up air quotes, “to enter the market.” That’s logical. It will spread out your average cost, but unfortunately about 70% of the time, by spreading it out over three years, you’ll end up paying more to get into the market. And this is intuitive if you think about it. About 70% of all calendar years, the stock market is up in value. So if you’re playing probabilities, lump sum investing will win about seven out of 10 times. If you are presently saving money systematically in a retirement plan or into a brokerage account or however you are doing that, volatility should be way down the list of your concerns, and in fact, you should be rooting for down markets all the way up until the moment you start taking distributions from your accounts.

I have three pieces of common wisdom that I’d like to rethink in a lightning round fashion before we jump into our recommendations portion of our case study with John and Jane Smith. The first is that investing only in US companies is the best strategy. Why not just invest in the S&P 500? Well, because there’s a cycle to everything and nothing outperforms forever. It seems somewhat inconceivable at this point with AI and tech leading the way and those dominant players here in the United States. How would the US underperform? You invest globally, not exclusively to increase returns, but to reduce concentration risk. For the first decade of the 2000s, we have dubbed that the last decade, because US stocks earned zero. While many other asset classes were certainly not lost, they did incredibly well. From January of 2001 through December of 2010, mid-cap US stocks were up 65%, small cap US stocks were up 78%. International developed markets were up 134% during that decade.

Here’s a wild one that almost makes you double take to check to see if this is right. While large cap US stocks earned zero for a decade, emerging markets was up 437%. Real estate was up 228%, and bonds were up 176%. You see, you invest internationally to smooth out your returns, which is really a question of diversification, and there’s a common belief that all diversification is better. No, I saw an announcement from a private equity fund that only invests in barrels of whiskey. Great. You like an old-fashioned, with your big square ice cube, that’s great. And yeah, you know what? It’s not correlated to the S&P 500, so it’s diversified in that way, but do you expect it to provide any sort of risk adjusted return? It’s like your friend that puts everything on the roulette wheel in Vegas. It’s all going on black. Why are you doing this with half of your life savings? And they answer, “Well, totally non-correlated to large US stocks. I want to be diversified.” You look at them and say, “Hey, you’re an idiot. I love you man, but you’re really dumb. That makes no sense.” There are two reasons you introduce diversification, it lowers risk. And relative to that, risk reduction provides a more efficient opportunity for growth, period. All diversification is not better. And my last piece of common wisdom to rethink together is that the stock market is risky. I hear this all the time. I don’t want to invest in the stock market because it is too risky. No, if you’re properly invested and you are broadly diversified, the more accurate thinking is that it is volatile. See, the longer that you’re in the market, the more positive, the worse case scenario becomes. So yeah, if you’re going to be invested in the stock market for one month, it’s a little better than a coin flip that you’ll make money. It’s very risky because of that volatility. Consider this, since 1950, the worst calendar year for US stocks was down 39%, while the worst 20-year annualized return was up 6% per year. For 20 years, that was your worst case scenario.

So when it comes to the stock market, it’s all about aligning your investment strategy with your financial plan and your objectives and more specifically your time horizon on when you’ll need to sell those investments. If you’re 25 years old and it’s in a company retirement plan that you can’t touch for 35 years, the stock market’s positive returns are fairly reliable. I mean, historically speaking, very reliable. If you buy into the stock market on a Monday and plan on selling it on a Wednesday, you’re right, it is risky.

If you have questions about your investments, your financial plan, taxes, estate planning, we help over 75,000 families in all 50 states and over 75 countries around the world and have been doing so since 1983. Why not give your wealth a second look? Speak to an advisor just like myself who’s not looking to sell you something but rather provide clarity around your life savings. Visit creativeplanning.com/radio now to meet with a local advisor.

Well, it’s time to revisit our real world case study with John and Jane Smith. They’re now in their third visit with us. And to catch you up on the first two visits together, they’re 63 and 61, five years away from retirement, have a net worth of about $3.4 million, and came to us wondering whether their retirement plan would work, as in could they retire over the next five years, and also have something left over for memories now with their family as well as fulfilling the priority they have in helping their two grandchildren pay for college.

We built out their financial plan in the last visit and they’re in good shape. Their projections show that they have over a $1 million surplus at retirement, and even while spending $200,000 a year, indexed for inflation will have just over seven and a half million dollars at John’s age.

So that’s the good news. They’ve done the heavy lifting, they’re there, but that doesn’t mean there aren’t opportunities for improvement, and that’s the purpose of this recommendations visit. From a financial independence standpoint, they no longer need to focus on getting rich. They need to ensure they stay rich. And based upon their objectives, how do we accomplish those by making adjustments to give them the highest probability of success?

Let’s start with their investments. There’s a big opportunity to lower the internal costs of their investments. They’re in many what I would consider antiquated retail mutual funds, paying high expense ratios. They’re under-diversified, as they have a high concentration in one individual company stock and are underweighted in some key asset classes that will provide volatility dampening by zigging when some of their other investments will zag.

Additionally, they can increase their bond exposure from about 15% to 25% of the portfolio now that they’re within five years of retirement and will be looking to make withdrawals certainly inside of the next seven to 10 years. And up to this point, as their time horizon was longer and they were buyers of investments looking for long-term growth, the previous allocation of more stocks made a lot of sense. There were a lot of opportunities from a tax standpoint because they hadn’t had any CPA integration and their advisor wasn’t either willing and/or able to really offer tax advice.

So on their $900,000 after tax brokerage account, we’re recommending moving from expensive mutual funds where you have to share in your neighbor’s taxes to a direct indexing account, meaning we’re going to unwrap the mutual fund or ETF wrapper and own the individual securities, for example, in the S&P 500, own all 500 stocks so that we have tax flexibility. Because even in years where the market is up, oftentimes there are hundreds of securities that are down. This will offer opportunities to tax loss harvest, to offset gains. And thanks to technology nowadays and our scale at Creative Planning, this strategy will also save them considerable costs and fees.

Also recommended that they remove taxable bonds from inside of that account because over the next five years, they won’t be spending any of that income. And right now they’re paying tax on that interest even though it’s being reinvested. And so we’re advising to shift those bonds into their retirement accounts where the interest is untaxed.

Fund the Roth side of their 401(k) plan, since they’re not over the $360,000 of income, which keeps them in the 24% bracket or lower, they’re not jumping into that 32% bracket. We’re also going to consider Roth conversions before the end of the year while the Trump Tax Reform is in place to use up some of those lower brackets. And from an asset location standpoint, just as we don’t want taxable bond interest in brokerage accounts, we also don’t want bonds in their Roth IRA accounts because those are generally the longest time horizon accounts, meaning those will be some of the last accounts that they ever touch.

There’s no required minimum distributions. They pass to future generations tax-free, which is a priority of theirs, and all the growth is tax-exempt. So you really want to achieve as much growth as possible inside of Roth accounts.

Their priority of education funding, our recommendation is to allocate 30,000 per year per grandchild. So 60 grand a year transferred from their brokerage account into 529 savings accounts. And the state that they’re in has a fantastic plan. It will provide for a state tax deduction, no federal deduction, but a state deduction. And that schedule will get the desired $150,000 into each grandchild’s account by their retirement date.

On estate planning, they have an outdated will and expressed a concern that if their children were to have issues with creditors down the road or what they felt was potentially more likely, I don’t know if they don’t like their in-laws, but they were worried about them getting divorced and their ex-spouses receiving some of the inheritance and they also want to pass some money onto those two grandchildren who are currently minors and aren’t able to directly receive an inheritance.

So we are recommending a full redo of their estate plan, creating a revocable trust, which by the way isn’t overly expensive. It doesn’t restrict their access to the monies along the way, but will help them avoid probate and we’ll create that customization to ensure that their inheritance is distributed to the exact people that they want to receive them and in the manner that they’d like them received. And they also don’t want one of their children to have to administer their estate if something were to happen to them. So they’ve asked that Creative Planning trust company handle the estate when the second one of them passes away.

And on their risk management, they only had state minimum limits and no umbrella policy with a growing net worth that is already approaching $4 million. So we’re recommending they slightly increase those at a minimal cost and also take out a $1 million umbrella policy to protect what they’ve worked so hard to save.

John and Jane Smith had done an incredible job positioning themselves to accomplish the goals that they had, but they had more risks than they needed bonds and other investments in the wrong types of accounts. They were spending an extra 20 grand per year in investment fees. 200 grand over the next 10 years, not for better returns because they weren’t aware of what lower cost options were available. And by the way, all those fees were internal. They weren’t seen until we showed them throughout the process exactly what they were paying. They weren’t saving from a tax perspective in the correct places, and they weren’t even certain that they could retire on time and fund their grandchildren’s college accounts and leave an inheritance. They were underinsured and had no current estate plan.

Here’s what’s neat about this process. We help them execute all of those improvements in-house with their CFP, who knows them inside and out, running point, looping in the attorney, looping in the CPA, bringing in the trust company, the trading team. And in just a couple of visits, John and Jane Smith had a comprehensive, customized plan that was visible and provided them clarity on what they’ve worked so hard for.

If you’d like to go through a similar process, if you think that’d be helpful for you to have an experienced independent advisor offering you tailored advice for your situation, speak with one of our advisors just like myself at creativeplanning.com/radio.

Well, it’s time for listener questions. And one of my producers, Lauren, is here as always to read those questions. Hey, Lauren. How’s it going? Who do we have up first?

Lauren Newman: Hi, John. First up we’ve got Pamela and she writes, “I’m older and unmarried. Overall I’m in good health, but I’ve been wondering what my options are when it comes to my health and estate, given that I do not have a spouse? Specifically, I’m curious about when and why having a healthcare power attorney or other options might be necessary for someone in my situation.”

John: Well, Pamela, this is a really important question for anyone over 18 to answer, but certainly in your situation specifically without a clear designated representative, it’s critical that you have the right documents in place because literally your life will be in the hands of whoever is making that decision.

Sometimes, it can be helpful to picture yourself not as the person incapacitated, but maybe as the child of a parent who became incapacitated. So imagine you arrive at your parents’ house for dinner and they’re unresponsive on the floor. Now maybe it’s your father. You go to the hospital and they tell you they had a seizure or they had a stroke and “We’re not sure exactly when they’re going to wake up. We’re doing everything that we can.” Well, first off, you’re going to be really sad about the situation, but then you’re going to start going into fight mode.

John: That’s how our brains are wired, is to be survivors. So you’ll likely start creating a list. “Does he have a mortgage? Does he have credit card bills or car payments?” All the responsibilities that your parent had previously taken care of, you’ll start wondering how you’re going to take care of those.

Now if they have a financial power of attorney in place, which is different than what you’re referencing, we’re talking about medical, but I just want to outline this first, that would provide the power for you to take care of those items. Now, on the medical side, if you’re back in that circumstance, someone has to make decisions for course of action. Oftentimes, the doctor’s going to say, “Here’s one option and here’s the other option. Here are the risks of one option. Here are the risks of the other option.” You need documentation to determine who is going to make that decision and you better trust them wholeheartedly.

Imagine in this scenario, you want to make a decision for your father, but there is no documentation that he had created via a medical power of attorney that authorized you to. And so now no treatment’s being done because there’s no one that’s legally allowed to make those decisions, certainly until the legal aspects are sorted out.

And so Pamela, in many cases, certainly if you’re being, I don’t want to say selfish in a bad way, but thinking more about how it impacts you, your financial and healthcare powers of attorney are way more important than a will, which would determine what’s going to happen to your assets after you pass away. The healthcare power of attorney could easily be argued for being the most important document to have in place. If you would like to meet with us, you could visit creativeplanning.com/radio to schedule that visit. All right, Lauren, next question.

Lauren: Next I’ve got Connor from Benton, Kansas and he says, “I’m newly married and my wife and I are looking to buy a house. What are your thoughts on taking 150,000 out of my investment accounts to offset the current mortgage rates? I’m in my late 30s and have about 300,000 in my account and have a long time before I need to retire.”

John: Well, congratulations, Connor, on your new marriage. A big part of merging your two independent lives together and all the decision making is certainly money. I think it’s great that you’re asking this question. And this really is the type of question that reminds us that personal finance is more personal than it is finance in many cases. However, without knowing all the details of your situation, I would not pull out money that’s earmarked for retirement if at all possible because it doesn’t just cost you the amount today, this $150,000, it costs you the difference between what you would’ve earned over the next, let’s say, 30 years if we want to tie it in with the term of the mortgage and what you’ll pay in interest.

So for example, if that $150,000 was invested in the stock market and it earned 7% the next 30 years, even if you had to pay 6% on a mortgage and you could never refinance, which is not the case, you’d still end up with over $200,000 more, even though you had to pay interest just by arbitraging to your advantage that 1% over three decades.

If you earned 8% on your money and paid a 6% mortgage, you end up with almost $300,000 more. But the reality is you’re not locked in to a 6% mortgage rate for the next 30 years because when rates drop, you are able to go refinance. And in that example, let’s say three years into your mortgage, you refinance at 4%. Again, I have no idea where rates are going, but to conceptualize this and you earn 8%, so there’s a 4% spread per year. By keeping the money invested and being willing to eat some of the interest charges over the 30 years of the mortgage on 150 grand, you have $500,000 more by not putting an extra $150,000 down.

Now also, this doesn’t factor in the extra liquidity and flexibility by not paying more on the house at the time of purchase. Because remember, once the money’s in the sheetrock of your home, you either have to sell the home or go to a bank, whether it be a cash-out refinance or a home equity line of credit, and hope that they’ll lend you money against the value of your home, which is not a guarantee.

In fact, a lot of times when times get hardest and you may lose your job and you need that money, I mean, yeah, it’s nice to have the mortgage payment be a little bit lower, but you’ve eaten into a lot of your liquidity, and those are the times where often banks deny the loan application.

Now I’m using hypotheticals of market rates of return. If you were someone even in your late 30s who said, “I don’t invest money other than I put it in government treasuries or a money market or a CD,” and that’s earning you 4% right now and your mortgage would be six and you’re not planning to allocate to more growth-oriented investments, then yeah, I’d pay more down on the house because at that point, the interest you’d be paying is a lot higher than your expected return. Also, you’re still young, but for someone who’s already checked the box on retirement, they’re way overfunded, paying cash for a house now can make the home buying process much easier. It can provide a competitive advantage if there’s a multiple bid scenario. So just paying cash to purchase the home and then planning to refinance when rates go down, maybe below 5%, or whatever that threshold is in your mind, can make sense as a short-term strategy.

Certainly if there’s someone who holds a lot of bonds in their portfolio that aren’t currently earning more than what the mortgage rate will be, again, that can make some sense. But for you in your late 30s, I’d keep the money you need growing in the market compounding and aggressively refinance as rates come down. All right, Lauren, last question.

Lauren: Marcus from Mission Beach, California asks, “Explain why you need to pay double the social security tax if self-employed, half employee, half employer>”

Yeah, this can be confusing, but you’re not paying double. You’re just paying all of it. Instead of only paying half when you were employed at a business and only paying the employee portion. So generally half’s paid by the employer, half’s paid by the employee. Yeah, so if you’re self-employed, you’re paying both sides of the 6.2% for social security, so 12.4 total, and you’re paying both sides of the 1.45 for Medicare or 2.9 total.

And remember that 12 plus percent on social security only applies to income below $168,600. Where Medicare, the smaller one, 2.9 total is uncapped. I mean, if you make $10 million a year, almost all of it’s above the social security threshold, but you’re still almost paying 3% on $10 million.

And if you have questions, just as these listeners did, email those to radio@creativeplanning.com.

Well, do you want a better life? I know you’re thinking, “Of course. Who’s answering no? That’s rhetorical.” We all want a better life. And the best way to accomplish that is to control what we allow in. I tell my kids all the time, “Show me your friends and I’ll show you your future.” My wife and I pay very close attention to who our children are spending the most time with. And this isn’t true of just children, it applies to us as adults as well. It’s hard to be your best self when you have negative inputs.

I meet with younger financial advisors who want my advice, and the number one thing I tell them is to go find people who are where you hope to be and lean into what they tell you. So it’s a good start if they see me as that person and inviting me to coffee or picking my brain, that’s what they should be doing.

In addition, listen to every possible interview when these people that you admire are guests on podcasts, subscribe to other podcasts of smart people that you respect within your profession. Read as many books by experts of where you’re hoping to go. Just consume as much as possible.

And this certainly applies to a lot more than our careers. You want to be a better parent? Go receive inputs from the best parents that you know, consume content from parents you respect. With personal finances, I hope that you feel like Rethink Your Money is a show that provides you with good inputs. And there are plenty of other fantastic shows out there as well that will give you the knowledge and the information and hopefully the encouragement to be a good steward of your resources.

I’m a Christian. One of the things that I notice is that if I start my day with even just five minutes in the Bible or saying a quick prayer to start my day, my entire mindset because of that input is different than the mornings where the first thing I do is go to my emails and start getting back to people or pulling up my ESPN app to look at stats from the night before, just meaningless stuff while I’m drinking my coffee.

I mean, everything else is the same. It was my mindset, which was controlled by what I consumed. What music are you listening to? What shows are you watching? What podcasts do you listen to? What books do you read? What friends do you hang out with? Where do you work? Which colleagues do you choose to spend time with? What food do you eat? Man, that’s a big one, isn’t it? You know how terrible you feel when you eat a meal with a bunch of fried food. I mean, you have a gut ache. You don’t want to do anything active, which is really different than when you’re on point with your diet.

So remember, what goes in is what comes out. The biggest contributor to your outputs are your inputs. And here’s the beautiful thing, you can’t 100% control your outcomes, but you can, and you do control the inputs. And remember, we are the wealthiest society in the history of planet Earth. Let’s make our money matter.

Announcer: Thank you for listening to Rethink Your Money, presented by Creative Planning. To hear past episodes or learn more about the topics and articles discussed on the show, go to creativeplanning.com/radio. And to make sure you never miss an episode, you can subscribe to Rethink Your Money wherever you get your podcasts.

Disclaimer: The preceding program is furnished by Creative Planning, an SEC-registered investment advisory firm. Creative Planning, along with its affiliates currently manages or advises on a combined $300 billion in assets as of December 31st, 2023. United Capital Financial Advisors is an affiliate of Creative Planning. John Hagensen works for Creative Planning, and all opinions expressed by John or his guests are solely their own and do not represent the opinion of Creative Planning or the station. This commentary is provided for general information purposes only, should not be construed as investment, tax, or legal advice, and does not constitute an attorney-client relationship. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable, but is not guaranteed. If you would like our help, request to speak to an advisor by going to creativeplanning.com. Creative Planning Tax and Legal are separate entities that must be engaged independently.

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